Latin American Elections Heighten Oil Supply Risks

A slew of elections and economic uncertainties in Latin America threaten to upend the region’s output and contribute to oil price volatility and uncertainty. Populist candidates in Colombia, Brazil, and Mexico have campaigned on dramatic new reforms for state-run oil industries and are now gaining momentum in some polls. In addition to ongoing economic turmoil in Venezuela, these political and economic uncertainties are bringing about increased geopolitical risk to oil markets amid growing global demand and OPEC’s successful strategy to draw down inventories in OECD countries and raise prices.

Resource nationalism has always been a fixture of Latin American politics, but the ebbs and flows of state ownership have been especially pronounced over the past decade.

Resource nationalism has always been a fixture of Latin American politics, but the ebbs and flows of state ownership have been especially pronounced over the past decade. Against the backdrop of crippling underinvestment and decades’ long stagnation, Mexico opened its state-run oil company Petróleos Mexicanos (Pemex) to private investment in 2013, permitting bids to some of its most promising offshore resources. Pemex, alongside a host of joint operators and partners, has found a number of discoveries in the offshore Gulf of Mexico over the past year. Brazil has also sought to reinvigorate its state-run industry, easing requirements for government participation in oilfield service contracts and auctioning new blocks in its immense pre-salt reservoirs.

However, international oil companies are proceeding with caution. Last February, Andrés Manuel López Obrador, the leading candidate for Mexico’s presidency, told a crowd that his government “will revise all these contracts” and “will not allow the oil, which is owned by the people and the nation to go back into the hands of foreigners.” With international oil prices now hovering below $80 per barrel ahead of Mexico’s July 1 election, López Obrador’s threats could have significant implications for U.S. refiners and oil producers. In 2017, the U.S. exported 1.1 million barrels per day (Mbd) of product to Mexico, amounting to a trade surplus with its southern neighbor.

Ongoing turmoil in Venezuela and dysfunction at the state-run oil company Petróleos de Venezuela (PDVSA) could similarly present challenges for the U.S. In March, imports of Venezuelan crude fell more by than 220,000 barrels per day year-on-year because of significant underinvestment, hyperinflation, and labor shortages. Internal PDVSA documents suggest an even more substantial shortfall in U.S. contracts for April. Observers say Venezuelan President Nicolas Maduro rigged his May 2018 reelection, prompting the United States to threaten more sanctions and a ban on importing crude oil from the South American country.

Latin America remains an important source of geopolitical supply risk, especially now, as OPEC and other participating nations gather in Vienna this week to discuss global output levels. Here is a snapshot of what’s at stake in Latin America.

Venezuela

Venezuela has large and low-cost oil reserves, but an economic crisis has overwhelmed the country and its oil sector. Last November, the government defaulted on $200 million in debt interest payments, which exacerbated the country’s persistent hyperinflation, unemployment, and food scarcity problems. A decade ago, PDVSA provided steady employment for a large segment of the population and promised stable pay and a pension for its workers. Rampant mismanagement and underinvestment, however, has forced workers to find new employment. In fact, PDVSA has historically been subject to creeping nationalizations and undo political influence. Former Venezuelan President Hugo Chávez frequently used the state oil company to fund his many economic, political, and social programs.

Venezuela’s economy was not equipped for the decline in export revenues that followed the 2014 oil price collapse. Production fell from a high of 2.7 Mbd in January 2015 to 1.4 Mbd last month. As one sign of the country’s ongoing dysfunction—output from independent operators has been stable compared to falling PDVSA production. But even they are now experiencing difficulties moving crude to market.

“We can expect to see a total collapse of the Venezuelan oil industry. We are rapidly getting there,” Council on Foreign Relations’ Energy Director Amy Myers Jaffe told Platts reporter Brian Scheid last week. Myers Jaffe said ships are experiencing difficulties moving products from ports, especially in the wake of ConocoPhillips’ recent lawsuit in which the company won $2 billion in damages against PDVSA. Political uncertainty following President Maduro’s reelection has also raised the specter of violence and continued deterioration. Venezuela’s collapse complicates OPEC’s strategy since the country is technically over-complying with its quota, but the sharp production decline has helped lift prices for other OPEC producers.

Colombia

In January, current President Juan Manuel Santos suspended negotiations with ELN, a Marxist guerrilla group, after they damaged three oil pipelines on the country’s Caribbean coastline. ELN is headquartered in the oil-rich city of Arauca and uses insurgent warfare tactics to protest the presence of foreign oil companies. The group’s domestic terror campaign has wreaked havoc on Colombia’s ecologically sensitive jungle regions and continues to disrupt supply lines. State-owned oil company Ecopetrol lost some 1.6 million barrels of crude in 2017 as guerrillas inflicted more than $6.8 million in infrastructure damage. A targeted bombing campaign in February shut down segments of the extensive Caño Limón-Coveñas pipeline for seven weeks.

The surprising popularity of a leftist guerrilla candidate could signal trouble for the industry down the road.

As largely predicted, conservative Ivan Duque won the presidency Sunday, but the surprising popularity of a leftist guerrilla candidate could signal trouble for the industry down the road. The run-off campaign left three major party challengers last month and marked the first time a liberal candidate rallied to win a third of the vote in traditionally conservative Colombia. But even now, a secured Duque government still comes with risk, as he promises to undo the historic peace deal with the Revolutionary Armed Forces of Colombia. Making good on this promise could escalate the conflict with the ELN and further threaten pipeline security.

Brazil

One decade ago, Petrobras was the shining example of a national oil company, the profitably of which delivered for the Brazilian people. Now, corruption, mismanagement, political interventions, and graft have left it in shambles. This month, truckers protested rising fuel prices, which immobilized Brazil’s economy for ten days. In response, deeply unpopular President Michel Temer announced a 60-day subsidy for diesel fuel, which cut pump prices by 12 percent. The president’s concession undid Petrobras Chief Pedro Parente’s reforms that sought to reduce the company’s debt burden and peg Brazil’s fuel prices to the international market. Parente’s subsequent resignation on June 1 cut the company’s stock value by roughly 20 percent overnight. Although public support for the strikes was widespread, many Brazilians have also expressed dissent for the temporary measure.

Investors nevertheless remain confident about Brazil’s resource potential. Sixteen oil companies recently convened in Rio de Janeiro to auction several blocks of Brazil’s offshore pre-salt reserves. International investors bid over $800 billion for the rights to explore the Campos and Santos basins, which could contain up to 14 billion barrels of oil. In 2007, the Brazilian government led by then-President Luiz Inácio Lula da Silva removed pre-salt acreage with Brent prices as high as $92 per barrel. However, a slew of political scandals and questions over the country’s ailing pension system have left its credit rating below investment grade. Brazil is looking to capitalize on its offshore oil reserves with anticipated prices far below 2007 levels. As the October 28 election approaches, these political cross-currents continue to raise questions over the long-term viability of Brazil’s partnerships.

Mexico

Mexico is set to elect former Mexico City mayor Andrés Manuel López Obrador in July. While López Obrador has walked back his hardline rhetoric regarding the 2013 Mexican energy reforms, global oil market observers remain wary of his policy proposals. Following many years of productive declines, Mexico’s oil sector reforms have loosened Pemex’s control of the industry. Oil giants, including ExxonMobil and BP have bought over $4 billion in investment in the country’s unexplored fields in recent years. Energy is now an important issue in the upcoming election with 48 percent of voters supporting the preservation of the 2013 reforms, according to a Brookings poll.

Yet, López Obrador’s cabinet nominees for the Energy and Finance ministries have vowed to “end the looting of Mexico” and close the door on oil tenders. These mixed messages continue to confuse markets and may represent a substantial political risk if López Obrador—who has been described as both a nationalist and a populist—abides by his earlier promises. With over 100 contracts issues since 2013, analysts say ending the reforms could cost Mexico up to $200 billion in development contracts. Other observers say López Obrador’s populist messaging is just that. As mayor of Mexico City, he promoted Mexican and foreign private capital for public and private development, such as the historic city centers with the help of Mexican billionaire Carlos Slim.

According to recent polls, the Mexican public wants change. Neither of the major party candidates are polling as well as the upstart López Obrador (whose party has never held the presidency). In addition, 61 percent of voters believe Pemex has not acted to the benefit of the country. With Mexico expected to participate in OPEC’s production agreement this month—and with deep rifts over United States trade now coming to a head—the industry is on edge. Duque’s victory in Colombia will help temper concerns, but the growing legitimacy of protectionist platforms signals that a shift in Latin America’s broader energy sector may soon follow. These economic uncertainties throughout the region have increased overall risk in oil markets, where declining inventories, OPEC action, and higher demand are already supporting prices.

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Issues in Focus

Safety Standards for Crude-By-Rail Shipments

A series of accidents in North America in recent years have raised concerns regarding rail shipments of crude oil. Fatal accidents in Lynchburg, Virginia, Lac-Megantic, Quebec, Fayette County, West Virginia, and (most recently) Culbertson, Montana have prompted public outcry and regulatory scrutiny.

2014 saw an all-time record of 144 oil train incidents in the U.S.—up from just one in 2009—causing a total of more than $7 million in damage.

The spate of crude-by-rail accidents has emerged from the confluence of three factors. First is the massive increase in oil movements by rail, which has increased more than three-fold since 2010. Second is the inadequate safety features of DOT-111 cars, particularly those constructed prior to 2011, which account for roughly 70 percent of tank cars on U.S. railroads. Third is the high volatility of oil produced from the Bakken and other shale formations, which makes this crude more prone towards combustion.

Of these three, rail car safety standards is the factor over which regulators can exert the most control. After months of regulatory review, on May 1, 2015, the White House and the Department of Transportation unveiled the new safety standards. The announcement also coincided with new tank car standards in Canada—a critical move, since many crude by rail shipments cross the U.S.-Canadian border. In the words DOT, the new rule:

Since the rule was announced, Republicans in Congress sought to roll back the provision calling for an advanced breaking system, following concerns from the rail industry that such an upgrade would be unnecessary and could cost billions of dollars. The advanced braking systems are required to be in place by 2021.

Democrats in Congress have argued that the new rules are insufficient to mitigate the danger. Senator Maria Cantwell (D-WA) and Senator Tammy Baldwin (D-WI) both issued statements arguing that the rules were insufficient and the timelines for safety improvements were too long.

The current industry standard car, the CPC-1232, came into usage in October 2011. These cars have half inch thick shells (marginally thicker than the DOT-111 7/16 inch shells) and advanced valves that are more resilient in the event of an accident. However, these newer cars were involved in the derailments and explosions in Virginia and West Virginia within the past year, raising questions about the validity of replacing only the DOT-111s manufactured before 2011.

Before the rule was finalized, early reports indicated that the rule submitted to the White House by the Department of Transportation has proposed a two-stage phase-out of the current fleet of railcars, focusing first on the pre-2011 cars, then the current standard CPC-1232 cars. In the final rule, DOT mandated a more aggressive timeline for retrofitting the CPC-1232 cars, imposing a deadline of April 1, 2020 for non-jacketed cars.

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DataSpotlight

The recent oil production boom in the United States, while astounding, has created a misleading narrative that the United States is no longer dependent on oil imports. Reports of surging domestic production, calls for relaxation of the crude oil export ban, labels of “Saudi America,” and the recent collapse in oil prices have created a perception that the United States has more oil than it knows what to do with.

This view is misguided. While some forecasts project that the United States could become a self-sufficient oil producer within the next decade, this remains a distant prospect. According to the April 2015 Short Term Energy Outlook, total U.S. crude oil production averaged an estimated 9.3 million barrels per day in March, while total oil demand in the country is over 19 million barrels per day.

This graphic helps illustrate the regional variations in crude oil supply and demand. North America, Europe, and Asia all run significant production deficits, with the Middle East, Africa, Latin America, and Former Soviet Union are global engines of crude oil supply.